In search of fiscal ‘win-win’ to spur upstream investment

Brazil and Guyana dominate the low end of the cost curve for pre-final investment decision projects. Both yield giant oil discoveries in world-class reservoirs – a winning combination that delivers outstanding project economics. Spectacular bids for Brazil pre-salt acreage in September prove that an industry that’s capital constrained still lusts after these resource sweet spots.

Not everywhere is so lucky with their rocks.
Most host governments are struggling to attract capital to offshore E&P. Though costs have come down, much more work is yet to be done for the structural reset needed to spur investment in many deepwater provinces. And it may be that the industry itself can only do so much. Fiscal terms, too, can deter investment in some basins, so governments are reviewing their terms in earnest.

We recently co-hosted a summit to assist this process, attended by fiscal policy-makers representing NOCs, energy and finance ministries from 17 countries. It was refreshing to hear the attendees discuss the current investment climate. They get it.

They know they need to be competitive and offer flexible, sustainable fiscal terms if they are to attract capital. They see the benefits of greater collaboration with industry, especially in understanding the prospectivity of their acreage.

And there is a growing feeling that the best way to establish their ‘fair share’ from future licences is simply to let the market decide – make the Government Share a bid item in licensing auctions. So far, so encouraging.

But there’s a problem: a lack of trust.
Summit attendees know that fiscal terms on existing projects should only be changed as a last resort. But politicians may see the manipulation of oil fiscal rates to address government budget shortfalls as a first resort. Or they may regard contracts signed by previous administrations as bad, or even corrupt – too favourable to the oil companies.

In some cases, these disputes can be settled by pragmatism and compromise. But it often degenerates to confrontation, investment paralysis and a ‘lose-lose’ situation. So governments know they need to develop appropriate, sustainable fiscal systems for fair weather or foul.

It takes two to tango.
Governments get angry when oil companies try to reduce an oil field’s economic rent by charging thousands of dollars to the cost recovery account for dog food and the CEO’s new aquarium.

Inflating, inventing and obfuscating chargeable costs is regarded as a problem endemic in oil companies.

We often hear ‘it’s in their DNA’. This perceived behaviour results in elongated cost audits and disputes, budgets failing to gain approval and projects being delayed. It’s another ‘lose-lose’ situation.

Some governments such as Indonesia have become so fed up, they want to change fiscal policy to a pure revenue-sharing system to avoid the process altogether. But such systems are generally regressive and more likely either to deter investment or fail to provide the government with a ‘fair share’ – and, therefore, less likely to be sustainable.

How can industry and government move beyond this trust impasse?
Graham Kellas, Head of Global Fiscal Research, sums up a way forward, predicated on increasing collaboration, transparency and communications:

1. Joint ‘competitiveness’ review boards where representatives from both industry and government to discuss areas of concern and best practice globally around fiscal terms, as well as geological prospectivity, local content and political risks
2. Digitise cost reporting so that all transactions can be traced and verified; only costs validated by electronic invoices/receipts will be acceptable (although still subject to scrutiny)
3. Benchmark local costs against global indices and evidence from comparable projects
4. Encourage governments to reduce risks (e.g. improve data availability, indirect taxation)
5. Develop fiscal systems that are flexible to changes in the economic environment and different types of investment; reduce/remove special allowances
6. If possible, ‘let the market decide’ fiscal rates in transparent auctions

There are many routes to a more harmonious relationship between industry and government. But the first step is to embrace transparency and collaboration. The current challenging environment for both sides provides the stimulus. Will they respond?